Efforts undertaken by reinsurance carriers to improve performance are starting to come through on an underlying basis, but while momentum is positive, there’s more work to be done, according to James Vickers, Chair of Willis Re International.
Reinsurance News spoke with Vickers around the launch of the reinsurance broker’s full-year 2020 Reinsurance Market report; which revealed growth in dedicated reinsurance capital of almost 7% to $658 billion.
Reflecting the market’s resilience and ability to absorb shocks, growth in capital occurred in a year which saw carriers navigate a global pandemic, the most active Atlantic hurricane season on record and ongoing challenges in other parts of the business.
Of course, the industry’s capital level was boosted by raises from both new and existing market players, but as noted by Vickers, it’s important to look at this in context.
“Although there has been $10 billion of new capital raised and $23 billion of net income, reinsurers gave back $26 billion through share buy-backs and dividends. So, the real driver of the increase in capital has been unrealized investment appreciation,” he explained.
Adding: “Everyone talks about the new capital being raised and yes, there has been some, but you need to look at it in the context of $548 billion of capital, and we’re talking about $10 billion. There’s more potentially coming in 2021, but it’s relatively small.
“I guess what we always forget about is, why do shareholders own stock of insurers and reinsurers? They want the dividend. So even in a year which isn’t particularly positive, they’re still paying out.”
In fact, continued Vickers, 2020 is just the second year in recent times where reinsurers have paid out more than their net income.
While industry capital growth was solid, the reported combined ratio for the subset of reinsurers in Willis Re’s report deteriorated year-on-year, ending 2020 at 104.1%.
However, once you remove the impacts of prior year reserves, COVID-19 losses, natural catastrophe losses and apply a five-year average to cat losses, the underlying performance of the sector, at least on the liability side of the balance sheet, has improved.
“On that basis, there has been an improvement in underlying combined ratio – it’s the first year since 2014 to show such an improvement,” said Vickers.
According to Willis Re, on an underlying basis, the combined ratio improved from 103.1% in 2019 to 100.7% in 2020.
“All the hard work that reinsurers have been doing over the last few years increasing prices, reducing limits and other underwriting remedies, is coming through on an underlying basis. It’s not yet enough, but it is moving in the right direction,” he continued.
According to Vickers, the problem is that if you apply the same logic to look at the overall return on equity (ROE) and deconstruct that, the underlying ROE has actually fallen from 3.2% to 1.2%.
Although, when you include investment income, the reported ROE looks healthier at 4.8%.
On the sector’s investment income, Vickers highlighted a running yield of 2.9% and an investment gain yield of 1.5% in 2019, which have both fallen.
“The investment gain yields have dropped from 1.5% to 1.2%. The real problem is the running yield gain of 2.9% to 2.2%, because that is the true reflection of reducing coupons, dividends and interest rate income,” he said.
Willis Re’s latest market report also explores the persisting subject of prior year reserve releases, which, Vickers cautioned are approaching a level of being almost insignificant.
“This happy tail wind has basically disappeared. It’s down to 1.5% ROE and it may even go negative over the next few years. But it’ll be several years before we reach a stage where it will be positive again. Because if 2021 is a very good underwriting year when companies set their reserves at the end of 2021, will they deviate from their recent ultimate loss ratio picks? Probably not. It’ll take a few years after that, so maybe in 2024 / 2025 before they can look at the 2021 underwriting year and say, we’ve got some reserve redundancy in there,” said Vickers.
The inability to rely on investment returns and prior year reserves means that ultimately, the industry needs to “drive down its combined ratio into the low 90s” to start meeting its cost of capital.
“It’s a very well capitalised market – capital isn’t the problem, it’s an underperforming market and until the performance side improves, I don’t think we’re going to see much evidence of easing off,” said Vickers.
Looking ahead to the remainder of 2021, Vickers said that if we have a reasonably good year, it will be interesting to see what carriers decide to do with the level of their share buy-backs and dividends.
“Capital could start to accumulate again. It will depend on the underlying growth of individual businesses as most management will give the dividends and share buy-backs that they’ve indicated they will do, but I suspect they will only increase them if they can’t find any profitable areas to put their capital to work.
“Hence, if the underlying demand is there, I think reinsurers will be interested in retaining capital and growing. Most companies are interested in growing because they see that the market conditions are better than they were a couple of years ago.
“The business is in a much better shape than it was two or three years ago,” he concluded.